In 2022, an independent research study was undertaken on key audit matter (KAM) reporting. The study, Communicating Key Audit Matters: A Post Implementation Review, can be found on The Atrium, University of Guelph, Department of Management; and YorkSpace, York University, School of Administrative Studies.
The study’s purpose was to better understand the Canadian KAM reporting experience of Toronto Stock Exchange (TSX)-listed entities and communicate relevant insights to auditors and other stakeholders to assist in future KAM communications.
This overview summarizes:
- the study’s key findings;
- the hints and tips from the study for the next implementation wave; and
- non-authoritative guidance to assist auditors in future KAM communications, including those who are implementing KAM reporting for the first time.
Disclaimer – The study, while funded by the Auditing and Assurance Standards Board (AASB), was independently performed by the researchers. They are responsible for the findings, which may not necessarily reflect the views of the AASB.
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Summary of Study Results
AASB staff noted the following key takeaways from the study:
A distinctive Canadian KAM reporting practice has developed
The study’s results show a distinctive Canadian KAM reporting practice characterized by:
- a lower average number of KAMs per audit report (1.55) compared to other jurisdictions that require KAM reporting (e.g., 1.7 in the United States,1 2.01 in Australia,2 and 3.27 in the UK3); and
- a general practice of not including the outcomes of audit procedures performed as part of KAM reporting.
Interview data suggests that the Canadian legal and regulatory environment had an important influence on the Canadian reporting practice, with auditors reporting a hesitancy to go beyond requirements of the auditing standards because of possible legal exposure. The result is a rigorous but “bare bones” KAM that reflects the legal constraints. Many of the auditor interviewees also mentioned aligning with the critical audit matter practices their U.S. counterparts used.
Less than 5 per cent of reports had zero KAMs. Most interviewees reported discomfort with the prospect of reporting zero KAMs, resulting in extensive consultations across the firm. However, auditors are also sensitive to the drawbacks of reporting a KAM for the sake of avoiding a zero-KAM report.
KAMs are customized for particular circumstances of the entity but there is little customization for recurring KAMs
Textual analysis of the KAM communications across the data set suggests that Canadian auditors are customizing their KAM descriptions and responses to the audited entities’ particular circumstances. In contrast, KAMs reported for the same entity on the same issue in consecutive years, which auditors refer to as “recurring KAMs,” are much less textually diverse. In most cases, the KAM includes few, if any, changes because the conditions that drove the KAM reporting in the first year persist. This atrophy to boilerplate is an inevitable and logical outcome, and over time, KAM reporting could become less useful. However, audit firms recognize the potential for complacency or familiarity bias and ensure that the review process challenges the engagement partner’s conclusions
The 2020 implementation of KAM reporting was well planned and executed
Interview data indicate that audit firms’ investments in training and other supporting activities to prepare for the KAM implementation served them well. The implementation of KAM reporting generally proceeded according to expectations, with auditors, preparers, and audit committee members reporting “no surprises” and few areas of sensitivity.
Limited benefits of KAMs
Most interviewees across all key stakeholder groups (i.e., auditors, financial statement preparers, audit committee members, and sophisticated financial statement users) did not find KAMs useful. The interview data for sophisticated financial statement users (including buy-side analysts, sell-side analysts, a regulator, and a credit analyst) suggests limited awareness of changes to the auditor’s report, including the existence of KAMs. Further, after reviewing KAM examples, users indicated they were unlikely to use the information, especially if the KAMs do not include outcomes of audit procedures performed. Within the context of the barrage of information available and their need to understand the current state of each entity’s prospects, sophisticated users viewed the KAMs as dated and insufficiently informative about the business or the business model.
However, the interview data for auditors and preparers did suggest some limited benefits to KAM reporting, for example:
- Some auditors responsible for engagement quality management have observed some improvements in financial statement note disclosures, possibly due to enhanced communication between auditors and management to ensure consistency between the financial statement note disclosure and the corresponding KAM.
- Some preparers, particularly those from organizations with less-developed governance structures and internal control systems, indicate that KAM reporting has provided them with an opportunity to push for improvements to address deficiencies in their business processes.
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Hints and Tips for the Next Wave
With TSX-listed entities having implemented KAMs for over a year, and with the next wave (e.g., non-TSX-listed entities) coming into effect for 2022, it is timely for auditors to consider lessons learned from the 2020 Canadian experience. The study included a link to some hints and tips based on the interviewees’ experiences and other findings, including the following:
- Start early to prepare relevant parties for the implementation of KAM – This may include clarifying the roles of auditors, financial statement preparers, and audit committee members with respect to KAM reporting.
- Perform a practice run of KAM reporting – This may include identifying potential risk areas and possible KAM disclosures and discussing them with relevant parties.
- Prepare for significant time demand in the first year of implementation – This may include budgeting time for drafting and refining KAMs and providing sufficient lead time for review.
- Remind clients and audit staff of the benefits of KAM – The benefits may include potential improvements to financial statement disclosures and business processes.
- Importance of first-year KAM reporting – Be aware that the first KAM reporting cycle may establish implicit expectations on matters such as the number and type of KAMs reported.
- Draft effective KAMs – This may include avoiding long or conditional sentences, using writing guides and involving other auditors to perform a “cold read” of the KAMs.
- Anticipate easier subsequent year experiences – The findings suggest that KAM reporting took up less time and that auditors, preparers, and audit committee members were more comfortable with the process in subsequent years.
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Guidance Available to Assist
In 2021, AASB Staff developed a series of non-authoritative guidance to help auditors, financial statement preparers and audit committees implement KAM reporting. The tips and hints the researchers identified highlight some of the key messages and guidance included in these existing materials.
- “Key Audit Matters: Insights for Stakeholders – Frequently Asked Questions”: This FAQ is for audit committee members, management, and other financial statement users. Auditors may find this FAQ helpful in helping relevant parties prepare for KAM.
- “Key Audit Matters: Lessons Learned from Firms Implementing KAM Communications on Audits of TSX-Listed Entities – Roadmap to Developing a Successful KAM-Implementation Process”: This guide helps audit firms with their KAM-implementation process and addresses considerations for practice runs.
- “Key Audit Matters: Lessons Learned from Firms Implementing KAM Communications on Audits of TSX-Listed Entities – Identifying and Communicating KAMs in the Auditor’s Report – Identifying and Communicating KAMs in the Auditor’s Report”: This guide provides considerations on identifying and communicating KAMs. Auditors may find this guide helpful when performing a practice run, implementing KAM in the first year, and considering ongoing KAM reporting.
CPA Canada has also published the following:
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According to the International Assurance and Auditing Standards Board (IAASB), KAM reporting was developed with the goal of addressing user demand for “additional information about matters of significance in the audit, which often will relate to areas in the financial statements that are subject to significant judgments by management and the auditor.”4
This study found that, in Canada, KAM reporting has not yet achieved its goal. However, Canadian implementation is still at an early stage; it has yet to come for audits of listed entities other than TSX-listed entities and users have only had two years to familiarize themselves with KAM reporting. Further, KAM reporting may yet benefit from future standard-setting developments. For example, analysts interviewed for the study indicated that KAMs, like financial statements, deal with “old information” and are generally not helpful for their purposes. The evolution toward integrated reporting and perhaps more reporting of forward-looking information, may impact the usefulness of KAM reporting.
This study was an important step by the AASB to continually assess its standards. The Board will monitor the Canadian KAM-reporting experience as it develops and matures and will continue its efforts to develop high-quality standards that respond to stakeholders’ needs.
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How Was the Study Conducted?
In the first quarter of 2022, the AASB staff commissioned a study on the implementation of KAM reporting in the Canadian market for TSX-listed entities with year-ends beginning on or after December 15, 2020.
Associate Professors Joanne Jones (School of Administrative Studies, York University) and Sandra Scott (Gordon S. Lang School of Business and Economics, University of Guelph) conducted the study, which consisted of:
- analyzing 618 audit reports reporting 0-6 KAMs, encompassing 895 KAMs in total; and
- interviewing 38 stakeholders, including auditors, audit committee members, preparers, and sophisticated users.
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- Public Company Accounting Oversight Board, “Interim Analysis Report: Evidence on the Initial Impact of Critical Audit Matter Requirements,” release no. 2020-002, October 29, 2020, 4.
- M. Kend and L. Nguyen, “Investigating recent audit reform in the Australian context: An analysis of the KAM disclosures in audit reports 2017-2018,” International Journal of Auditing 24(3) (2020): 412-430.
- E. Deneuve, A. Filip, and A. Jeny, “Client-specific information in Key Audit Matters and audit risks,” working paper (2022).
- IAASB, Auditor Reporting – Key Audit Matters, International Federation of Accountants, New York, January 30, 2015, np.
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